Morning Commentary: Who’s Scared of Inflation?

Foreign Exchange - Morning Commentary
Who’s Scared of Inflation?
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
In a world uncertainty, there appears to be one certainty in the markets—the promise of aid as needed from policy makers.  Case in point, the US has pushed out over $4 trillion in stimulus with even more to follow.  With so much money floating around the system, it seems that runaway inflation could be a major concern. 

It is important to remember that there isn’t a direct link between stimulus and inflation.  Instead, stimulus increases demand and if demand is greater than supply, then inflation is created.  In the current environment, stimulus is attempting to replace lost activity and prevent an even bigger fall in output and consumption as the sudden shutdown in activity has led to a collapse in both aggregate supply and aggregate demand. 

As a result, the near term risk is for deflation rather than inflation despite the massive amount of money injected into the economy.  This dynamic has played out in product pricing where the price rise in essential items, such as cleaning products, has been more than offset by fall in prices elsewhere. 

Even when the economy reopens, deflationary pressures will likely dominate.  Consumer confidence should remain challenged and income levels should be depressed compared to before the pandemic.  The expected output gap should result in continued deflationary pressures. 

Further out, the picture is less clear.  Should governments continue to stimulate the economy after demand begins to normalize then stimulus could be inflationary.  An interesting question regarding inflation concerns localization.  If companies choose to de-globalize, production processes become less efficient and could put subtle upwards pressure on pricing.  More acute pricing pressure would come from involuntary localization such as due to a trade war between the US and China that is out of mind but far from over.
  • Oil prices continue to fall as demand for oil evaporates.  As of this writing, crude prices are sitting below $12 a barrel, a level not seen since the late 1990s.  Beyond demand, the lack of storage space is also an issue with oil producers in Texas getting as little as $2 a barrel and a small landlocked crude stream known as Wyoming Asphalt Sour selling for negative 19 cents.  As would be expected, commodity currencies, especially the CAD and NOK, are being hit. 
  • Congress and the White House continue to negotiate the next wave of stimulus measures for the economy with hopes that the bill will be able to pass Congress by the end of the week. 
  • Earnings season picks up steam this week and could bring a reality check to the markets.  About 20% of firms, by market cap, will report earnings this week with next week bringing earnings from another 40%.  The US has suspended tariff payments on certain goods to avoid another cash flow pressure exacerbating poor earnings.  Expect earnings news and COVID-19 headlines to be two key drivers for risk this week.
  • Brexit negotiations will kick off again this week with both sides still far apart.  For the UK’s part, it still maintains that it will not seek an extension, reminding the world of hard Brexit risks that have been overshadowed by COVID-19 headlines.  
  • In virus news, US cases rose 5.6% from Saturday to Sunday which is higher than the 4.8% average over the past week.  Vice President Mike Pence will discuss the lack of testing with governors today.  Around the world, the news has been mixed with Germany reporting the smallest increase in cases and deaths in a month but Singapore’s daily infection rate topping 1,000 for the first time. 
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